2020-04-04 IFR Magazine

International Financing Review April 4 2020 49

STRUCTURED FINANCE

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because of the coronavirus.

The plan would complement measures

already announced to give mortgage

borrowers and renters payment holidays of

up to three months.

The FCA is carrying out a swift

consultation on its proposals, giving lenders

until Monday morning next week to

respond ahead of potential implementation

next Thursday.

The FCA also wants zero interest to

be paid on overdrafts of up to £500,

for up to three months. It had already

announced changes to overdraft rules,

coming into effect on Monday, and

says lenders should make sure

borrowers are no worse off under the

revised rules than they would have

been previously.

And the FCA also proposes that

borrowers’ credit ratings would not suffer

if they use any of the new proposed

measures.

“These measures would provide an

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support for consumers who until now

Banks stuck with loans after CLO market shuts

„ COLLATERALISED LOAN OBLIGATIONS No mark-to-market means forced sales unlikely

Banks in Europe are funding billions of euros

of leveraged loans that were destined for

refinancing through CLO new issues but have

plunged in value over the course of March.

But market participants are not expecting a

wave of unwinds or liquidation for what Barclays

estimates are €4bn–€6bn of loans in bank

warehouses. And a tentative reopening of the

new-issue CLO market in the US on Thursday

provides a glimmer of hope for a restart in

Europe too.

Market participants believe there are 40–50

warehouse facilities in Europe, which allow

managers to ramp up leveraged loan portfolios

before exiting with term CLO securities sold to

end-investors.

The handful of banks most active in arranging

CLOs – Bank of America, Barclays, BNP Paribas

and Citigroup – are likely to hold the largest

amount. Some warehouses will already be at

€300m or higher while others will be just getting

started.

Warehouses are typically split into a senior

portion funded by the bank and a junior portion,

of 20%–30%, held by equity investors –

sometimes including the CLO manager.

Those equity investors will now be feeling the

pain of falling loan prices.

“Warehouses were holding assets at close to

par and now the assets are trading somewhere

in the 80s, so warehouse equity investors are

sitting on something like at 50% loss on their

investment,” said one CLO banker.

DRAWSTOP EVENTS

Few warehouses in Europe are structured with

mark-to-market mechanisms that require equity

investors to post additional collateral or be

forced to liquidate.

But there are typically mark-to-market

triggers, or drawstop events, which can prevent

managers from adding any more loans to the

warehouse until values recover, and those are

almost certain to have been breached.

However, Geoffrey Horton, CLO and loan

strategist at Barclays, said in a research note

that some warehouse equity investors might

allow the manager to take advantage of current

low loan prices and buy more assets now before

waiting for a larger recovery in the future.

As for maturities, most warehouses give

borrowers around 12 months to ramp up their

portfolio and exit into the term market. But that

is usually followed by an amortisation period of

around 12 months if there is no term take-out.

That suggests an immediate wave of forced

warehouse unwinds is unlikely. Bankers expect

managers will use the time to hold fast and wait

to see if there is an improvement in the market.

“Managers with relatively more ramped

portfolios, where the ability to average down

at current loan prices is more difficult, will

likely instead look to price deals as soon as the

primary market begins to thaw,” Horton said.

At current spreads, though, a traditional term

CLO backed by loans bought before March looks

very difficult. CLOs only make money for equity

investors if the loan portfolio throws off more

cash than is needed to pay debt investors, and

secondary trading shows spreads on CLO debt

are now far too wide for that to happen.

For example, spreads on CLO Triple As,

which usually account for around 60% of the

stack, have widened to 250bp over Euribor and

beyond, from 90bp just a few weeks ago.

PRINT AND SPRINT

However, portfolios of loans bought after the

spread widening began are of course paying

much more. And indeed on Thursday in the US,

manager Blackstone/GSO sold a US$476.70m

CLO which bankers away from the deal said was

backed by loans bought since March 9.

Even so, the deal’s sub-investment grade

bonds were retained, suggesting market

prices for that risk might have made the deal

uneconomical.

And unlike typical deals, the new issue –

called STRATUS CLO 2020-1 – is static and has a

very short one-year non-call period.

Bankers say more such opportunistic so-

called “print and sprint” deals may be lining up

in the US.

And behind them, managers are said to be

touting deals backed by loans they bought

before the spread widening.

“It is very difficult to say if those deals

[ramped-up before March] will actually happen,

and how the economics would work,” said a

second CLO banker.

“But if there is activity in the US, then that

points to something happening in Europe too in

the near-term.”

One motivation for an equity investor to term

out a new issue, even if it means putting more

money into the deal, would be the expectation

that loan values recover and the manager can

benefit from a pull-to-par to offset some of the

losses crystallised when the deal was taken out

of the warehouse.

“But if their view is this is a long-term

disruption, and the CLO equity will perform

badly too, they may well not want to roll into the

CLO and may just want to exit with as little loss

as possible,” said the first CLO banker.

“So it’s really a question of what their

warehouse equity investors’ view of CLO equity

is and how deep their pockets are – how much

they’re prepared to put into the transactions.”

At root, any judgements about loan

performance hinge on predictions about the

spread of the coronavirus and how long major

economies remain in limbo.

S&P, for example, ran stresses to European

CLO ratings which showed Triple As typically

resilient and Triple Bs remaining investment

grade in most cases.

It assumed the coronavirus pandemic peaks

between June and August, and that the sub-

investment corporate default rate could rise to 8%.

Moody’s, meanwhile, is working to three

scenarios: a sharp but short contraction, a

recession similar to the 2008 financial crisis, and

a more severe recession.

Those three scenarios give sub-investment

grade corporate defaults of 6.8%, 16.1% and

20.8%, respectively.

And with governments and healthcare experts

still reluctant to make firm predictions about the

spread of the coronavirus and the length and

severity of the economic fallout, it is asking a

lot for CLO market participants to find enough

conviction to do so.

Chris Moore

6 IFR Bonds 2327 p 25 - 65 .indd 49 03 / 04 / 2020 20 : 29 : 01